Question

A company will issue new common stock to finance an expansion. The existing common stock just paid a $1.25 dividend, and dividends are expected to grow at a constant rate 6% indefinitely. The stock sells for $45, and flotation expenses of 6% of the selling price will be incurred on new shares. The beta of this company is 1.34. What is the cost of new common stock for this company?

Answer 1

Information provided:

Current dividend= $1.25

Current stock price= $45

Dividend growth rate= 6%

Flotation cost= 6%

Beta= 1.34

Cost of new common stock= D1/ Po*(1 – f) + g

Where:

D1= Next year’s dividend

Po= current stock price

f= flotation cost

g= growth rate

Ke= $1.25*(1 + 0.06)/ $45*(1 – 0.06) + 0.06

     = $1.3250/ $42.30 + 0.06

     = 0.0313 + 0.06

     = 0.0913*100

     = 9.13%.

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